To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER DISCUSSION QUESTIONS Q1-1 Planning is the development of a consistent set of actions, resources, and measurements by which the achievement of objectives can be assessed Planning takes into account the interactions between the organization and its environment in whatever is to be done Control is the process by which managers assure that resources are obtained and used in an efficient and effective manner to carry out the plan and accomplish the organization’s objectives Control implies that performance measurements are reviewed to determine if corrective action is required Planning and control are interrelated Control is carried out within the established planning framework and serves to evaluate conformance to the plan so that organizational objectives are achieved Q1-2 Short-range plans usually deal with a period of a quarter or a year, while long-range plans usually cover three to five years Short-range plans are detailed enough to permit preparation of a complete set of financial statements as of a future date, while long-range plans culminate in a very summarized set of expected results or a few quantified objectives, such as financial ratios Q1-3 Long-range plans contain quantitative results, while strategic plans are the least quantifiable of all plans Long-range plans usually extend three to five years into the future, while strategic plans may contemplate shorter or much longer periods Long-range plans covering a three-to-five-year period would be prepared every three to five years, or might be systematically updated each year to maintain a complete plan, while strategic plans are formulated at irregular intervals by an essentially unsystematic process Q1-4 Accountability is identical with responsibility accounting Accountability deals with the discharge of an individual’s responsibility to achieve assigned objectives within the costs and expenses allowed for the performance and agreed to by the individual Q1-5 The controller does not control, but aids the control task of the managerial levels by issuing reports pointing out deviations from the predetermined course of action Q1-6 The cost department keeps detailed records of materials, labor, factory overhead, and marketing and administrative expenses; analyzes these costs; issues control reports; prepares cost studies for planning and decision making; and coordinates cost and budget data with other departments Q1-7 For product research and design, the manufacturing departments need estimates of materials, labor, and machine process costs; for measuring and efficiency of scheduling, producing, and inspecting products, the departments need to know the costs incurred The personnel department supplies employees’ wage rates The treasury department needs accounting, budgeting, and related reports in scheduling cash requirements The marketing department needs cost information in setting prices The public relations department needs information on prices, wages, profits, and dividends in order to inform the public The legal department needs cost information for keeping many affairs of the company in conformity with the law Q1-8 Modern techniques in communications give the controller and staff the means to transmit information in the form of results, analyses, and forecasts in a way never before possible Profit opportunities or control actions have been delayed or missed entirely because timely information that might have improved the cost and profit position of the company was poorly communicated Q1-9 The budget is an essential cost planning tool because it (a) supplies information and serves as a standard of performance for cost control by the supervisors responsible for cost; (b) provides an easy method for anticipating profits at an anticipated sales level; (c) helps in forecasting sales, costs, expenses, and profits for a period of one year or more in advance 1-1 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 1-2 Q1-10 These standards will not necessarily be able to prevent management fraud, but they give internal accountants some guidance on how to proceed if they encounter a questionable practice Q1-11 CASB standards: (a) enunciate a principle or principles to be followed; (b) establish prac- Chapter tices to be applied; (c) specify criteria to be employed in selecting from alternative principles and practices in estimating, accumulating, and reporting contract costs The standards are backed by the full force and effect of the law To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 1-3 EXERCISES E1-1 The exercise requires two examples of the inseparability of planning and control Three are listed here, and the third one gives two illustrations: The most obvious example of the inseparability of planning and control is found in the definition of control: management’s systematic effort to achieve objectives by comparing performance to plans and taking appropriate action to correct important differences The definition shows that the specific results of planning are an essential input to the control phenomenon; there cannot be any such thing as a control effort without reference to some set of plans A second example of the inseparability of planning and control results from the fact that they are simultaneous In practice, the implementation of the first steps of a plan, and any control action needed in those steps, are begun before all parts of planning are complete Early results and the early findings of control activity can then be used in finalizing later parts of the same plan An example is that a single annual budget is usually not completely finalized before customer orders begin to be received for that year, and consideration of the number of these actual customer orders may point to trends that need to be considered in finalizing the budget Even actual financial results of the early weeks and months of the year can provide a basis for better establishing the budget for the later portion of the year The most elegant example of the inseparability of planning and control results from the fact that both planning and control are complex human activities, and almost all complex human activities are planned activities and also controlled activities In other words, planning can be so complex that the planning effort is itself controlled (and planned), and control can be so complex that control activities are themselves planned (and controlled) Two illustrations of this are provided as follows: (1) A case in which planning is itself planned and controlled is when a complicated budget (plan) is to be prepared To facilitate the creation of the budget, a detailed weekly schedule (another plan) is first agreed upon, showing which steps in the preparation of the budget are to be carried out during each week Because it is desired that the creation of the budget not be allowed to fall far behind schedule, the responsible manager will exercise control by making comparisons between (a) the actual progress made on the budget each week and (b) the schedule The manager will also take some corrective action if the difference between the schedule and the actual progress is considered important (2) A case in which control is itself planned is when a manager decides what kinds of control reports will be used to compare actual results with plans in each future period of business operations That decision, any efforts made to acquire a supply of preprinted report forms to be filled in each period, and any changes in the design of the cost accounting system to capture and compile the needed information about actual results represent evidence that the future control activity is being planned To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 1-4 Chapter E1-2 (1) (2) (3) (4) (5) (6) B A C A C B—although the time frame involved in this kind of plan may be extremely long, there is nothing strategic about this kind of plan or decision In fact, the plan and obligation to pay off the bonds when they come due is so routine that management would not consciously approach it as a decision E1-3 (1) (2) Paragraph (b) comes closest to describing the kind of control used in managing a business, although it is described in a nonbusiness setting There is a plan formulated in advance, there is a measure of actual results, there is a decision maker who compares actual results with plans, there is a selection of a corrective action to bring results closer in line with the plan, and there is a foreshadowing of repeated periodic control activities (the remaining quizzes) The fact that the measures of planning and actual performance are nonfinancial measures is not the governing consideration Much planned and actual information used in controlling a business is non-financial, including some cost accounting information such as the number of units produced, the percentage of units that were defective, and the percentage of available machine time that was utilized Paragraph (a) is a perfect example of an engineering control, rather than the kind of control managers use in business The simple device described, which is found in any home bathroom, is the kind of control device designed to monitor a physical condition, and so it is analogous to a thermostat or any of a variety of devices called “industrial controls.” Of course, devices of this kind are used in manufacturing and other businesses, but they not possess the essential attributes of control in the sense used in business and in cost accounting The device achieves a continuous monitoring of the results, rather than a periodic comparison of results with plans There is no human decision maker who selects a corrective action to be taken A human decision maker is probably the salient attribute of control in managing a business that is missing in paragraph (a) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 1-5 E1-3 (Concluded) Paragraph (c) could be interpreted as an example of planning, but it lacks some essential ingredients of control (even though the word “control” is used in its last sentence) There is no periodic comparison of actual results with plans and no provision for modifying the treatment based on periodic results For example, the contract requires five treatments each year, even if no weeds are visible The actions taken are entirely preemptive Paragraph (d) refers to the concept of control that applies to police work and military science It consists of being able to physically determine each event that occurs in some location and being able to prevent certain events from occurring The potential use of coercive force, which is very clear in paragraph (d), is always present in achieving this kind of control In paragraph (d), there is no indication that results were periodically compared with plans A rule that says “Obtain the objective at any cost” is sometimes associated with these activities To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 1-6 Chapter CASES C1-1 (1) (2) (3) Yes, Williams has an ethical responsibility to take action The IMA’s Standards of Ethical Conduct states that management accountants “shall not commit acts contrary to these standards nor shall they condone the commission of such acts by others within their organizations.” (The requirement does not ask which standards have been violated, but, rather, which ones apply to Williams’ situation.) Management accountants have a responsibility to: Competence: Perform their professional duties in accordance with relevant laws, regulations, and technical standards (Dumping toxic wastes in a residential landfill is generally a violation of law.) Confidentiality: Refrain from disclosing confidential information acquired in the course of their work except when authorized, unless legally obligated to so (Williams may be legally obligated to take action and make certain disclosures.) Integrity: Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives (Williams’ avoidance of the issue would passively subvert attainment of ethical objectives.) Communicate unfavorable as well as favorable information and professional judgments or opinions (Williams is obligated to report his unfavorable findings to appropriate persons.) Refrain from engaging in or supporting any activity that would discredit the profession (Williams’ silence would provide support to the dumping activity and, thus, could discredit the profession.) Objectivity: Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented (Williams should disclose his findings to the appropriate persons.) Alternative (a), to seek the advice of his immediate superior, is appropriate This is the first step he is required to take, unless the superior is involved Alternative (b), communication of confidential information to persons outside the company, such as the local newspaper, is inappropriate unless there is a legal obligation to so If required by law, Williams should contact the proper authorities Alternative (c), contacting a member of the board of directors, would be inappropriate at this time Williams should report the problem to successively higher levels within the company and turn to the board of directors only if the problem is not resolved at lower levels To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 1-7 C1-1 (Concluded) (4) Williams should follow the company’s established policies for resolving such issues, if such policies exist If the issue is not resolved through existing policies, he should report the problem to successively higher levels within the company until it is resolved (Williams is not required to report this action to his superior if his superior appears to be involved in the conflict He is not to disclose the matter to persons outside the organization, unless required by law.) During these steps, Williams may clarify relevant concepts by confidential discussion with an objective advisor to obtain an understanding of possible courses of action If the conflict is not resolved after exhausting all these courses of action, Williams may have no other recourse than to resign and submit an informative memorandum to an appropriate representative of the organization Consultation with one’s personal attorney is also appropriate C1-2 (1) (The requirement does not ask which standards have been violated, but, rather, which ones apply to the CFO’s behavior.) Management accountants have a responsibility to: Competence: Perform their professional duties in accordance with relevant laws, regulations, and technical standards (The CFO has asked Deerling to account for information in a way that is not in accordance with generally accepted accounting principles.) Prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information (The CFO’s restrictions on disclosure will result in incomplete reports.) Confidentiality: Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage, either personally or through third parties (The CFO is attempting to use confidential information to protect the job security and bonuses of top management.) Integrity: Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict (The CFO has failed to avoid a conflict of interest and has not informed the stockholders of the conflict.) Refuse any gift, favor, or hospitality that would influence or would appear to influence their actions (The CFO’s bonus appears to be an influence on his actions.) Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives (The CFO has subverted the attainment of the organization’s legitimate objective, profit for stockholders, by pursuing, instead, the job security and bonuses of top management.) Communicate unfavorable as well as favorable information and professional judgments or opinions (The CFO is attempting to restrict disclosure of information about the acquisition.) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 1-8 Chapter C1-2 (Continued) (2) Refrain from engaging in or supporting any activity that would discredit the profession (The CFO’s actions could discredit the profession.) Objectivity: Communicate information fairly and objectively (The CFO is attempting to unfairly control the information reported, resulting in a report that is not objective.) Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented (The CFO is attempting to restrict disclosure of relevant information.) (The requirement does not ask which standards have been violated, but, rather, which ones apply to Deerling’s situation.) Management accountants have a responsibility to: Competence: Perform their professional duties in accordance with relevant laws, regulations, and technical standards (Deerling is being asked to violate generally accepted accounting principles.) Prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information (Deerling is being asked to prepare an incomplete report.) Confidentiality: Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage either personally or through third parties (Deerling must not use the confidential information about the possible takeover to his own advantage or to that of the person(s) mounting the takeover attempt.) Integrity: Refuse any gift, favor, or hospitality that would influence or would appear to influence their actions (The last sentence of the case suggests that Deerling is considered a member of the top management group, so he may be eligible for a bonus.) Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives (Deerling is being asked to subvert the attainment of the organization’s legitimate objective, profit for stockholders, by pursuing instead the job security and bonuses of top management.) Communicate unfavorable as well as favorable information and professional judgments or opinions (Deerling is being asked to restrict disclosure of information about the acquisition.) Refrain from engaging in or supporting any activity that would discredit the profession (Deerling is being asked to take actions that could discredit the profession.) Objectivity: Communicate information fairly and objectively (Deerling is being asked to prepare a report that is not objective.) Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented (Deerling is being asked to restrict disclosure of relevant information.) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 1-9 C1-2 (Concluded) (3) (4) If the company has established policies for dealing with such issues, Deerling should first follow these policies If such policies not exist, or if they are unsuccessful in resolving the problem, Deerling should present the problem to the chairman of the board Deerling’s immediate superior is involved, so he need not be informed of this action If the matter remains unresolved, Deerling should report to the audit committee, the board of directors, and finally the majority owners During these steps, Deerling may clarify relevant concepts by confidential discussion with an objective advisor to obtain an understanding of possible courses of action If the conflict is not resolved after exhausting all these courses of action, Deerling may have no other recourse than to resign and submit an informative memorandum to an appropriate representative of the organization Consultation with one’s personal attorney is also appropriate The primary responsibility the company must fulfill before taking defensive actions is its fiduciary responsibility to stockholders Other responsibilities include the effects that the takeover and defensive actions would have on creditors, bondholders, employees, customers, and the community The company also has a responsibility to inform its external auditors and legal counsel to avoid putting them in a compromising position C1-3 (1) (The requirement does not ask which standards have been violated, but, rather, which ones apply to Dixon’s behavior.) Management accountants have a responsibility to: Competence: Maintain an appropriate level of professional competence by ongoing development of their knowledge and skills (By systematically rejecting all minority applicants, Dixon is jeopardizing the level of competence among the staff.) Perform their professional duties in accordance with relevant laws, regulations, and technical standards (Equal opportunity in employment is required by law.) Integrity: Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict (Dixon’s prejudice is in conflict with the company’s legal obligation to provide equal opportunity employment, and with the company’s need for the most competent staff regardless of race.) Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives (The company’s objective of equal opportunity employment is being subverted by Dixon’s prejudice.) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 1-10 Chapter C1-3 (Concluded) (2) (3) (4) Refrain from engaging in or supporting any activity that would discredit the profession (Such persistent, systematic discrimination in hiring could discredit the profession.) (The requirement does not ask which standards have been violated, but rather, which ones apply to Foxworth’s situation.) Because management accountants may not condone the commission of unethical acts by others within their organizations, all of the responsibilities listed in the solution to requirement (1) also apply to Foxworth’s situation In addition, the following apply: Management accountants have a responsibility to: Confidentiality: Refrain from disclosing confidential information acquired in the course of their work except when authorized, unless legally obligated to so (Foxworth’s suspicions about Dixon’s behavior should not be disclosed inappropriately See requirement (3)) Objectivity: Communicate information fairly and objectively (Foxworth is obligated to make objective hiring recommendations to Dixon, in spite of his belief that Dixon will be prejudiced in acting on them.) Alternative (a), discussion with the director of personnel, who is one of Dixon’s peers, is inappropriate at this time If, however, Foxworth believes the director of personnel is an objective party, Foxworth may discuss the matter with the director, confidentially, to clarify the relevant concepts and to obtain an understanding of possible courses of action Alternative (b), informal discussion with a group of MAD senior management accountants, is inappropriate Alternative (c), private discussion with the CFO, Dixon’s superior, is appropriate Because Foxworth has already approached his immediate superior, Dixon, who is involved in the conflict, it is not necessary for Foxworth to inform him of this action Foxworth should follow the company’s established policies for dealing with this type of conflict, if such policies exist If policies not exist, or if they are unsuccessful in resolving the conflict, Foxworth should discuss the issue with the CFO If the matter remains unresolved, discussions with successively higher levels of management, including the audit committee and the board of directors, should follow During these steps, Foxworth may discuss the matter confidentially with an objective advisor to clarify the relevant concepts and to obtain an understanding of possible courses of action If the matter remains unresolved after exhausting all of these steps, Foxworth may have no recourse other than to resign and submit an informative memorandum to an appropriate representative of the company Consultation with one’s personal attorney is also appropriate To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 25-12 Chapter 25 P25-3 (Concluded) (Note to instructors: This problem is based on an actual case The directive to the two divisions’ management teams, as described in requirements and 6, is the approach actually taken by top corporate management In the admittedly difficult circumstances, that directive to the two divisions’ management teams probably represents a good compromise between the imperative of not idling the new facility and the competing desire to preserve divisions’ autonomy in decision making The outcome was a successful one The two divisions’ general managers emerged from the conference room with a lengthy, detailed, written agreement The agreement called for the producing division, Magnussen, to reduce its price steadily during the first few years of production The buying division, Anderson, agreed to pay a full-cost-based transfer price initially, but there was to be a separate accounting of the “excess” transfer prices paid The “excess” was defined as the amount by which the transfer price exceeded the competing price of the outside supplier, multiplied by the quantity of product transferred between the two divisions at that transfer price The total accumulated excess, plus imputed interest on it, eventually was to be reimbursed to Anderson by Magnussen in the form of future discounts Provided Magnussen could achieve large gains in efficiency through its experience in producing the new product, the arrangement was designed to be profitable to both divisions in the long run and, of course, to avoid a loss of the $100,000,000 investment in the production facility Due to learning curve effects, Magnussen’s full-absorption production cost fell below $20 per pound within a few years.) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 25 25-13 P25-4 (1) Based on variable manufacturing cost to produce the cushioned seat and the Office Division’s opportunity cost, the transfer price is $1,869 for a 100-unit lot or $18.69 per seat, computed as follows: Variable cost $1,329 Opportunity cost 540 Transfer price $1,869 This transfer price was derived as follows: Variable Cost: Cushioned Material: Padding $ 2.40 Vinyl 4.00 Total cushion material $ 6.40 Cost increase (10%) ×1.10 Cost of cushioned seat Cushion fabrication labor cost ($7.50 × DLH) Variable factory overhead* ($5.00 per DLH × DLH) Total variable cost per cushioned seat Total variable cost per 100-unit lot $ 7.04 3.75 2.50 $13.29 $1,329 *Variable overhead for 300,000 hours: Supplies Indirect labor Power Employee benefits: 20% of direct labor and indirect labor (excluding 20% of supervisors’ salary which is a fixed cost) ($575,000 – (20% × $250,000)) Total variable overhead at 300,000 direct labor hours Variable overhead per DLH ($1,500,000 ÷ 300,000 DLH) $ 420,000 375,000 180,000 525,000 $1,500,000 $5.00 per DLH To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 25-14 Chapter 25 P25-4 (Concluded) Opportunity cost: Labor hour constraint: Labor hours to make a 100-unit lot of deluxe office stools (1.50 DLH × 100 units) Less labor hours to make a 100-unit lot of cushioned seats (.5 DLH × 100 units) Labor hours available for economy office stool Labor hours required to make one economy office stool 50 hours 100 hours hour Use of extra labor devoted to economy office stool production (100 hours ÷ hour) 125 stools Deluxe Office Stool $58.50 Economy Office Stool $41.60 $14.55 11.25 $15.76 Selling price per unit Less manufacturing costs: Materials Labor: ($7.50 × 1.5 DLH) ($7.50 × DLH) Variable factory overhead: ($5.00 per DLH × 1.5 DLH) ($5.00 per DLH × DLH) Total cost per unit Contribution margin per unit Units produced Total contribution margin Opportunity cost of shifting production to the economy office stool ($2,520 – $1,980) (2) 150 hours 6.00 7.50 $33.30 $25.20 × 100 $2,520 4.00 $25.76 $15.84 × 125 $1,980 $ 540 Variable manufacturing cost plus opportunity cost would be the best transfer price system to use because it would allow the supplying division to be indifferent between selling the product internally to another division or selling the product in the external market This transfer price method assures that the supplying division’s contribution to profit would be the same under either alternative The sum of the variable manufacturing cost and the opportunity cost represents the effort put forth by the supplying division to the overall well-being of the company An appropriate transfer price must attempt to fulfill the company objectives of autonomy, incentive, and goal congruence While no one transfer price can necessarily satisfy each of these objectives fully in all situations, the variable manufacturing cost plus opportunity cost transfer price should be the most appropriate method for meeting these objectives in most situations To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 25 25-15 P25-5 (1) In order to maximize short-run contribution margin, the Cole Division should accept the contract from Wales Company This conclusion is supported by the following calculations: Cole Division transfer to Diamond Division Transfer price (3,000 units × $1,500 each) Variable cost: Purchase from Bayside Division (3,000 units × $600 each) $1,800,000 Variable processing cost in Cole Division (3,000 units × $500 each) 1,500,000 Contribution margin $4,500,000 3,300,000 $1,200,000 Cole Division sales to Wales Company Sales price (3,500 units × $1,250 each) Variable cost: Purchase from Bayside Division (3,500 units × $500 each) $1,750,000 Variable processing cost in Cole Division (3,500 units × $400 each) 1,400,000 Contribution margin 3,150,000 $1,225,000 Conclusion: Contribution margin from transfer to Diamond Division Contribution margin from sales to Wales Company Difference in favor of Wales Company contract $1,200,000 1,225,000 $ 25,000 $4,375,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 25-16 Chapter 25 P25-5 (Concluded) (2) Cole Division’s decision to accept the contract from Wales Company is in the best interest of Robert Products Inc because the decision increases the overall corporation’s contribution margin This conclusion is supported by the following calculations: Revenues and cost savings to Robert Products Inc.: Sales by Cole Division to Wales Company (3,500 units × $1,250 each) Sales by Bayside Division to London Company (3,000 units × $400 each) Cost savings (variable costs avoided by not accepting the Diamond Division order): Bayside Division’s savings (3,000 units × $300 each) Cole Division’s savings (3,000 units × $500 each) Expenditures incurred by Roberts Products Inc.: Variable cost incurred for the Wales Company order: Cole Division (3,500 units × $400 each) Bayside Division (3,500 units × $250 each) Variable cost incurred for Diamond Division purchase from London Company (3,000 units × $1,500 each) Variable cost incurred for London Company order from the Bayside Division (3,000 units × $200 each) Positive overall contribution margin for Robert Products Inc $4,375,000 1,200,000 900,000 1,500,000 $7,975,000 $1,400,000 875,000 4,500,000 600,000 7,375,000 $ 600,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 25 25-17 CASES C25-1 (1) The return on capital employed has definite limitations for evaluating the performance of the Dexter Plant Too many factors used to compute the return are not within the control of plant management A significant portion of the “return” side of the measure is determined by the action of higher level management— sales and allocated costs The plant management appears to have effective control over only a part of the costs incurred at the plant level, and the same is true for the asset base Corporate and division assets are allocated to the plant In addition, it appears that specific assets may be charged to the plant even though the decision was made at a higher level (2) The case states that recommendations for promotions and salary increases for plant managers are influenced by the comparison of the budgeted return on capital employed to the actual return It appears that this plant manager is reacting in direct response to this measurement system Two events have occurred outside his control (the sales decline and extra land charges), which will reduce his return on capital employed measure He has responded by influencing those components of the measure that he controls and that will improve this measure The reduced costs—training, maintenance, repair, and certain labor—would not affect sales volume in the short run It is also likely that reduction of inventory levels will not influence the sales in the short run Through these actions he has improved his return for 20A, but it may well be at the expense of 20B, or later years C25-2 (1) The shortcomings, or possible inconsistencies, of using rate of return on capital employed as the sole criterion to evaluate divisional management performance include the following: (a) Rate of return on capital employed tends to emphasize short-run performance at the expense of long-run profitability In order to improve short-run profits, managers may make decisions that are not in the best interest of the company over the long run (b) Rate of return on capital employed is not consistent with cash flow models used for capital expenditure analysis and, therefore, may not be comparable for divisions that use different accounting methods or that have assets purchased in different periods (c) Rate of return on capital employed may not be controllable to the same extent by all division managers, i.e., the divisions may sell in different markets with different degrees of product development, competition, and consumer demand To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 25-18 Chapter 25 C25-2 (Concluded) (d) The use of a single measure of performance, such as rate of return on capital employed, may result in a fixation on improving the components of the one measure to the neglect of needed attention to other desirable activities—research and development, employee development, and improvement of market position (2) The advantages of using multiple measures in evaluating divisional management performance include the following: (a) Multiple performance measures provide a more comprehensive picture of performance by considering a wider range of management responsibilities (b) Multiple performance measures emphasize nonquantitative as well as quantitative aspects of performance, thereby providing an incentive for divisional managers to engage in desirable activities, such as research and development, employee development, and improvement of market position, as well as to seek profitability (c) Multiple performance measures will mitigate the problem of trying to compare divisional performance with a single measure that may be computed on different bases in each division (d) Multiple performance measures include long-term as well as short-term incentives, thereby emphasizing total performance rather than just shortterm profit maximization (3) The problems or disadvantages of implementing a system of multiple performance measures include the following: (a) The measurement criteria are not all equally quantifiable and, therefore, it may be difficult to compare the overall performance of one division with another (b) Central management may have difficulty applying the criteria on a consistent basis Some criteria may be subjectively more heavily weighted than other criteria at different points in time, and some criteria may be in conflict with other criteria (c) A multiple performance measurement system may be confusing to division managers, thereby resulting in diffusion of effort and instability in performance To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 25 25-19 C25-3 (1) (a) Average operating assets employed: Balance at 12/31/20F Balance at 12/31/20E ($12,600,000 / 1.05) Beginning plus ending balances $12,600,000 12,000,000 $24,600,000 Average balance ($24,600,000 ÷ 2) $12,300,000 Rate of return on = Income from operations before taxes capital employed Average operating assets employed = $2, 460, 000 $12, 300, 000 = 20% (b) Income from operations before taxes $2,460,000 Minimum return: Average operating assets employed $12,300,000 Charge for invested capital × 15% 1,845,000 Residual income $ 615,000 (2) Yes Presser’s management probably would have accepted the investment if residual income were used The investment opportunity would have lowered Presser’s 20F rate of return on capital employed because the expected return (16%) was lower than the division’s historical returns (19.3% to 22.1%) as well as its actual 20F rate (20%) Management rejected the investment because bonuses are based in part on the rate of return performance measure If residual income were used as a performance measure (and as a basis for bonuses), management would accept any and all investments that would increase residual income (i.e., a dollar amount rather than a percentage), including the investment opportunity it had in 20F (3) Presser must control all items related to profit (revenues and expenses) and investment if it is to be evaluated fairly as an investment center by either the rate of return on capital employed or the residual income performance measures Presser must control all elements of the business except the cost of invested capital, which is controlled by Lawton Industries To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 25-20 Chapter 25 C25-4 (1) Divisional profit Add corporate headquarters allocation Adjusted divisional profit ($000 omitted) Marine Airline Plastics $ 5,100 $1,050 $ 9,360 3,450 1,185 570 $ 8,550 $2,235 $ 9,930 Divisional capital employed Deduct corporate headquarters allocation Adjusted divisional capital employed $20,400 970 $19,430 $5,000 252 $4,748 $36,000 941 $35,059 Adjusted divisional rate of return on capital employed 44% 47% 28% $ 8,550 $2,235 $ 9,930 3,886 $ 4,664 950 $1,285 7,012 $ 2,918 Adjusted divisional profit Less 20% of adjusted divisional capital employed (minimum level of income) Residual income (2) All three divisions have a reported rate of return on capital employed in excess of the 20% target rate However, Marine Division management apparently turned down its investment opportunity because the investment had a lower rate of return than the division (24% for the investment versus 25% for the division), which, if accepted, would have lowered the division’s rate for the year, thereby lowering the annual bonus Similarly, Airline Division management appears to have avoided fleet replacement for the same reason (i.e., fleet replacement return is 16% versus 21% for the division for the year) Plastic Division’s management has achieved the maximum bonus allowable under the current bonus system and therefore had no incentive to increase profit (which may have been viewed as something that could simply increase next year’s budget) The revised figures indicate that all three divisions are performing well; however, Marine Division’s residual income is greater than the other two divisions combined (3) Airline Division is making an adjusted profit of $2,235,000 and residual income of $1,285,000 The adjusted rate of return on capital employed is 47%, which suggests that the target rate should be revised in order to properly evaluate it Nevertheless, since the division is achieving more than double the present target rate of 20% and more than either of the other two divisions, it appears to be a very good investment However, fleet replacement should be examined along with the computation of a new adjusted rate of return on capital employed and residual income Assuming that the $25,000,000 capital investment does not include any corporate headquarters allocation and that the old fixed assets have a book value equal to market value, the recomputation follows: To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 25 25-21 C25-4 (Concluded) Incremental division profit Add corporate headquarters allocation Adjusted incremental division profit Add adjusted divisional profit without fleet replacement Adjusted divisional profit with fleet replacement $ 4,000,000 135,000 $ 4,135,000 2,235,000 $ 6,370,000 Division current assets Division fixed assets (fleet replacement cost) Adjusted divisional capital employed with fleet replacement $ 2,748,000 25,000,000 Adjusted rate of return on capital employed 23% Adjusted divisional profit Less 20% of incremental capital employed Adjusted incremental residual income $ 6,370,000 5,549,600 $ 820,400 $27,748,000 Even when adjusted, the rate of return on capital employed is above the corporate target level and the incremental residual income is positive Furthermore, assuming that profits not fall in the future, the return on assets employed should rise in the future because the amount of assets employed will decline due to depreciation As a result, it appears that from a quantitative perspective the airline should not be sold Nevertheless, the investment required to replace the fleet should be evaluated using one of the capital expenditure evaluation techniques that considers the time value of money (e.g., the net present value method or the discounted cash flow rate of return method) From a qualitative perspective, factors such as spill-over business, offering a full line to customers, ultimate profitability when the economy improves, possible advantage to a competitor from the sale of the division, etc., may override quantitative analysis (4) The bonus scheme should be based on residual income rather than rate of return on capital employed in order to avoid the problem of managers making suboptimal decisions from the corporation’s overall perspective (5) The divisional performance measures should be computed without allocations of corporate headquarters costs or assets, because such allocations are arbitrary and divisional managers cannot control such costs or the use of such assets Also, capital investments (such as the ones faced by the Marine Division and the Airline Division) should be evaluated by using the capital budgeting evaluation methods (such as the net present value method or the internal rate of return method) CGA-Canada (adapted) Reprint with permission To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 25-22 Chapter 25 C25-5 (1) (2) (3) (4) General criteria that should be used in selecting performance measures to evaluate operating managers include the following: (a) The measures should be controllable by the manager and reflect the actions and decisions made by the manager in the current period (b) The measures should be mutually agreed upon, clearly understood, and accepted by all the parties involved (c) The measures should (1) reward long-term performance; (2) tie incentive compensation to achieving strategic (nonfinancial) goals, such as target market share, productivity levels, improvement in product quality, product development, and personnel development; and (3) evaluate operating profits before gains from financial transactions; before deductions for approved expenditures on research and development, quality improvements, and preventive maintenance; and before deductions for the incremental amount of accelerated depreciation A major expansion of Star Paper’s plant was completed in April, 20A This expansion included additions to the production-line machinery and the replacement of obsolete and fully depreciated equipment As a result, the value of the division’s asset base increased considerably While productivity undoubtedly increased during the first year in the expanded plant, the increase was not immediate nor sufficient to offset the increase in the value of the capital employed Apparent weaknesses in the performance evaluation process at Royal Industries include the following: (a) There was no mutual agreement on the use of return on capital employed as the only measurement of performance (b) The feedback from Fortner was insufficient Fortner indicated that Harris would receive feedback about the questions raised concerning the appropriateness of using the return on capital employed to evaluate performance, but feedback was not provided (c) The single measure of performance may give a distorted picture of actual performance at Star Paper A single measure could encourage division management to make decisions that could improve short-run return at the expense of long-run profits Examples include deferring maintenance, avoiding plant modernization, eliminating employee training, discontinuing research and development, etc Multiple performance evaluation criteria would be appropriate for the evaluation of the Star Paper Division The criteria suggested by Harris take into account more of the results of the key decision being made by the manager, are not in conflict with each other, and emphasize the balance of profits with the control of current assets These three measures are controllable by division managers and, in conjunction with return on capital employed, provide a more complete picture of business success To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 25 25-23 C25-6 (1) The 20B bonus pool available for the management teams of each division follow: Meyers Service Company Bonus Pool = 10% × income before income tax and bonuses = 10 × $417,000 = $41,700 Wellington Products Inc Bonus Pool = 1% × (Revenue – Cost of Product) = 01 × ($10,000,000 – $4,950,000) = 01 × $5,050,000 = $50,500 (2) Two of the advantages and two of the disadvantages to Renslen Inc of the bonus pool incentive plan at Meyers Service Company follow: Advantages (a) The management team will be motivated by the bonus plan because they have the opportunity to earn additional compensation if they work hard as a team and take some risks for the company (b) Because management shares in the benefits of efficient operations, there is an incentive to control all costs (product costs as well as overhead costs) and to promote sales Disadvantages (a) The plan may motivate management to increase the “bottom line” only and concentrate on the short run The plan may encourage managers to sacrifice quality or avoid new product development for the sake of current profits (b) Management may postpone necessary expenditures such as maintenance or research and development in order to increase current net income Two of the advantages and two of the disadvantages to Renslen Inc of the bonus pool incentive plan at Wellington Products Inc follow: Advantages (a) The management team will be motivated by the bonus plan because each manager has the opportunity to earn additional compensation by working hard and taking some risks for the company (b) The managers will be encouraged to sell the most profitable mix of products Disadvantages (a) The plan omits accountability for all costs except for production costs Therefore, managers may feel no obligation to control the costs that are shown below the gross profit line (b) The plan may cause managers to focus all energies to maximizing current sales and production regardless of the impact this could have on the manufacturing plant There is a strong motivation to defer maintenance, employee training, quality improvement, etc., because the incentive is to produce and sell high volume To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 25-24 Chapter 25 C25-6 (Concluded) (3) (a) Having two different incentive plans for the two operating divisions could result in behavioral problems and may reduce teamwork/synergy between the two divisions if the managers of either division believe they are being treated unfairly The management team at Meyers Service may believe that they have to work harder to achieve their bonuses because they are responsible for all costs and must achieve overall efficient operations to earn substantial bonuses The management team at Wellington Products may believe that they have less of an opportunity to affect the size of the bonuses they receive because only changes in sales and/or product costs will increase the gross profit These perceptions of inequity could lead to decreased motivation that could result in decreased divisional performance (b) In order to justify having different incentive plans for the two divisions, Renslen management could argue the following: (1) The goals and products of the two businesses are different (one is a service organization while the other is a manufacturing organization) and, therefore, should be measured on different criteria For example, the control of manufacturing costs and improved productivity may be the most important factor in maintaining Wellington Products’ competitiveness, while it may be critical for Meyers Service to control all costs to maintain profitability (2) The plans were in place when the businesses were acquired and had proved satisfactory, previously To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 25 25-25 C25-7 (1) In terms of what is best for the total company in the long run, Omar probably should not supply Defco with Electrical Fitting #1726 for the $5 per unit price In this case, it appears that Omar and Defco serve different markets and not represent closely related operating units Omar operates at capacity; Defco does not No mention is made of any other interdivisional business In the long run, Gunnco Corporation is probably better served if Omar is permitted to continue dealing with its regular customers at the market price If Defco is having difficulties, the solution probably does not lie with temporary help at the expense of another division, whose sales to regular customers could be lost The proposed course of action should not be followed unless it will yield a greater long-run profit for the total company (Gunnco) than will any other alternative (2) Gunnco would be $5.50 better off, in the short run, if Omar supplied Defco Electrical Fitting #1726 for $5 and sold the brake unit for $49.50 Assuming that the $8 per unit for fixed factory overhead and administrative expenses represents an allocation of the costs Defco incurs, regardless of the brake unit order, Gunnco would lose $2.50 in cash flow for each fitting sold to Defco, but would gain $8 from each brake unit sold by Defco (3) In the short run, there is an advantage to Gunnco of transferring Electrical Fitting #1726 at the $5 price and, thus, selling the brake unit for $49.50 To make this happen, Gunnco will have to overrule the decision of Omar’s management This action would be counter to the purposes of decentralized decision making If such action were necessary on a regular basis, the decentralized decision making inherent in the divisionalized organization would be a sham Then the organizational structure is inappropriate for the situation On the other hand, if this is an occurrence of relative infrequency, the intervention of corporate management will not indicate inadequate organizational structure It may, however, create problems with division managements In the case at hand, if Gunnco management requires that Electrical Fitting #1726 be transferred at $5, the result will be to enhance Defco’s operating results at the expense of Omar This certainly is not in keeping with the concept that a manager’s performance should be measured on the results achieved by the decision he or she controls Omar is operating at capacity and would lose $2.50 ($7.50 – $5) for each fitting sold to Defco The management performance of Omar is measured by return on investment and dollar profits Selling to Defco at $5 per unit would adversely affect those performance measures To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 25-26 Chapter 25 C25-8 (1) The Lorax Electric Company will earn higher profits if the necessary integrated circuits (ICs) are sold to the Systems Division rather than to regular customers The improved profit will be $1.00 per clock system as shown below Contribution margin from clock system: Proposed sales price…… Less variable production costs: Integrated circuits IC378 (5@ $.15) Outside components Circuit board etching Assembly, testing, packaging Contribution margin per unit on clock system Contribution margin forgone in Devices Division: Sales price of IC 378 Variable production costs Contribution margin per circuit Units for clock system Contribution margin lost Net advantage to Lorax Company if clock system is produced by Systems Division (2) (3) $7.50 $ 75 2.75 40 1.35 5.25 $2.25 $ 40 15 $ 25 × 1.25 $1.00 /unit Intervention by executive management generally is not advisable, except in unusual circumstances, because it takes away the delegated decision power given to division management and influences the measures used to judge the performance of division management It conflicts with important objectives of decentralization—division autonomy over operating decisions and decisions made by those closest to the operating scene Such interference can result in lower morale and poorer performance by division management because they will be evaluated using measures that are not substantially within their control However, a division should not be allowed to make a decision that is not in the best interest of the total company over the long run The described policy would avoid the need for intervention by executive management or an arbitration committee However, the policy is undesirable because other unfavorable consequences outweigh this benefit With the described policy, there would be no analysis to determine the most profitable use of an item required to be transferred at variable cost In addition, a division manager would have less control over the division’s operations, and there would be an “uncontrollable” influence on the manager’s performance measure; this could result in lower morale for managers ... manufacturing cost = 1/3 × prime cost, so: = prime cost + factory overhead = prime cost + (1/3 × prime cost) = 4/3 × prime cost; multiplying both sides by 3/4 gives: Total 3/4 × manufacturing cost 3/4... to a reduction in customer orders (3) The total cost expected to result from producing the first batch of 300 units of Zeggo is: Cost accounted for as direct cost of a unit $ Cost treated as... Chapter C2-2 (Concluded) (6) For the one additional unit, the CCN cost accounting system will report a cost of $5 + $10 = $15 (7) The additional costs allocated by the CCN accounting system are